No Surprises As Base Rate Is Held

Posted on: 10 July 2008 by Gareth Hargreaves

The Bank of England maintains the interest rate at 5 per cent.


On 10th July 2008 the Bank of England's Monetary Policy Committee (MPC) voted to maintain the official Bank Rate paid on commercial bank reserves at 5 per cent.

The last change in Bank Rate was a reduction of 0.25 percentage points on 10th April.

"The fact that the MPC has held the base rate at 5 per cent is fairly expected," says James Caldwell, Fairinvestment.co.uk director, "and confirms the view held by many economists that the MPC is more concerned about rising inflation than the slowing domestic economy."

"Although a cut may have restored consumer confidence, with inflation well above target, it is difficult for the MPC to cut rates, and seeing as mortgage lenders have so far refused to pass on the two cuts made earlier this year, a further one was unlikely to have had much affect on mortgage affordability anyway."

Given Bank of England Governor Mervyn King's remit to explain inflation that exceeds the central bank's target, Simon Rubinsohn, RICS chief economist says, "Crucially, there is at this stage very little evidence of second round effects from the jump in food and energy costs. That said, it is not surprising that the Bank wants a little more convincing that inflation expectations are not ratcheting upwards."

Last month's letter from the Governor to the Chancellor, and his reply, explaining why the Bank had failed to meet its inflation target, was encouraging, according to Ray Boulger of John Charcol, the independent mortgage adviser.

"It made it clear that the MPC was prepared to take the medium to long term view on the impact the severe downturn in the economy will have on inflation and will not be panicked into increasing Bank Rate just because of the current spike in inflation, which it is powerless to stop."

Meanwhile, says Rubinsohn, the release of the latest house price figures from the Halifax underlines the deteriorating fortunes of the housing market.

"Tighter bank lending is restricting transaction activity and hitting confidence. While this is in part a function of the wider economic problems, there are still measures that the government can take to ease the pain of first time buyers."

Borrowers may be best off looking at tracker rates, advises Boulger.

"On the back of the market reassessing its view since last month on where Bank Rate is heading, 2 year swap rates have fallen by a little over 0.5 per cent from last month's 6.5 per cent peak and 3 month Libor has fallen 0.1 per cent to 5.85 per cent. Some lenders have reduced their fixed rates to partially reflect the lower swap rates and even some tracker rates have been cut."

"For borrowers who want or need the security of a fixed rate mortgage, playing a waiting game should offer the opportunity to fix at rates lower than those available today."

"However, current rates on the best tracker mortgages are around 0.5 per cent lower than the best fixes and so unless Bank Rate averages more than 5.5 per cent over the deal period, fixed rates will end up costing more. In fact with Bank Rate likely to fall further, the gap between current fixed rates and a tracker mortgage is likely to widen, making trackers the current mortgage of choice for borrowers taking a view on interest rates."

Looking to the future, Sebastian Mackay, Senior Economist at Scottish Widows Investment Partnership (SWIP) says, "Concerns over UK earnings, growth, inflation, interest rates and oil price are all placing increased pressure on the UK market and we expect UK economic growth to slow quite sharply as residential investment falls and consumers turn more cautious. The more competitive level of sterling may give some boost to exports, but overall, we expect to see GDP growth slow from 3.1 per cent last year to 1.6 per cent this year."

"With the prospect of an additional rise in gas and electricity prices, we also expect inflation to rise in the second half of this year, with some likelihood that it could exceed 4 per cent."

"Against this background, it is going to be difficult for the Monetary Policy Committee to cuts interest rates in the short term. However, we expect four quarter point cuts in the Spring and Summer of 2009, taking the bank rate down to 4 per cent by the third quarter of next year."

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